May 20, 2022

Weekly Summary: May 16 – May 20, 2022


Key Observations:

  1. Forecasting difficulties were prominently displayed by both Walmart and Target this week. Supply constraints and disruptions have necessitated the abandonment of “just-in-time” inventory policies. This has increased the necessity of accurate forecasting at a time when the great number of variables has diminished the probability of accurate forecasting.
  2. Margins at both Walmart and Target were very disappointing relative to expectations as consumer spending patterns quickly changed, and these companies were unprepared for these changes. Faulty forecasting was also to blame for “over-hiring” at Walmart due to overestimating the time that employees would be out on leave because of COVID-19-related issues. Amazon had similar over-staffing issues. Many analysts and investors were quick to focus on this as an indication that the labor market tightness might dissipate quickly. We chose to wait for more data related to this issue.
  3. There are increasing indications that U.S. consumer spending might be slowing and that U.S. economic growth is also slowing.
  4. We still await downward revisions of margins and earnings from analysts.


The Upshot: We continue to interpret recent trading in U.S. equities as pricing in an elevated chance of a recession within the next twelve months. This does not mean that such an outcome is inevitable. We surmise that this view has taken hold of the markets along with the assumption that the Russia-Ukraine war will persist for quite some time. As we highlighted in last week’s commentary, diminished liquidity in financial markets has likely exacerbated volatility. Even accounting for a relatively modest downturn at the end of the day, we thought that U.S. equities were attempting to find a short-term bottom on Thursday as they were relatively stable throughout the day. We even might have a short-term increase in equity prices. We will be quick to change our opinion in regard to short-term market movements. But we do not think that this will be a sustainable bottom. The severe downturn in U.S. equities on Wednesday was characterized by about 10% less volume than the prior 20-day average daily. We would expect much more volume if this were a more sustainable bottom. We also doubt that we could have a sustainable bottom until analysts finally downgrade their margin and earnings estimates. We believe that a prerequisite also might include “clear and convincing” evidence that elevated inflation is headed lower and that tightness in the labor market will begin to ease in a noticeable manner. Given our assumptions, we continue to anticipate that global economic growth forecasts will be lowered and that inflation forecasts will be raised. We were encouraged by the almost 1% drop in USD as represented by U.S. Dollar Index (DXY) on Thursday. We could be putting in a USD top, which according to our prior analysis could be beneficial for global growth. We still favor diversified portfolios that consist of high quality stocks as well as some commodity exposure. We will continue to look for opportunities to take advantage of market volatility.


Lessons Learned from Shaggy’s Song “Repent”

We all can learn something from Shaggy’s song “Repent.” As U.S. equities continue to appear that they are pricing in higher probabilities of recession and/or stagflation, sometimes it might feel like “we’re two steps away from a real disaster.” But that does not mean necessarily that we are heading for a real disaster. After checking the “state of the world we live in,” we agree with Shaggy that “it’s a crying shame” to see the current state of the world characterized by much turmoil and uncertainty. In the current environment, with its uncertainties and severe downturns in equity prices, it is understandable that among some investors: “Tempers flare and patience wear; Ten finger pointin but who is to blame?” I guess for a lot of people it just must be easier to find someone else to blame. As Walmart and Target discovered this week, “life set a pace, every thing’s much faster” as consumer spending patterns shifted rather abruptly from what both of these companies had anticipated, along with many analysts and investors. We have observed that since the onset of the pandemic, most everything seems to be evolving at a pace of change that is faster than we have become accustomed. As we have highlighted in many of our prior commentaries, Russia’s invasion of Ukraine, sanctions against Russia and China’s “zero-COVID-19” policies with their accompanying mass testing and lockdowns have all contributed beyond COVID-19 itself to uncertainties as the number of variables has multiplied and uncertainties have increased. Supply chain constraints and disruptions have often been very unpredictable on their timing and impact. As we have previously highlighted, a strong U.S. Dollar (USD) has only made things more complicated and has clouded forecasts further.

Instead of bringing our country “closer together” as we had hoped, the pandemic seems to have led to even more divisiveness. A prime example of this is that vaccination policies incredibly have become a political issue, instead of a scientific inquiry. Like almost every approach in solving important national and global issues, “instead of finding a cure we should look for the means to prevent.” It appears that many people are trying to adopt the position of “boss” and then tell us what to do. Our response should be: “Think there’s a boss but who are the master?” In the final analysis, it is our opinion that each one of us must be the “master” and take responsibility for our own actions. Furthermore, no one is exempt from having something for which to “repent”.


Preferred Strategies for Long-Term Investors

This has obviously been a very difficult time for most long-term investors. It appears that the most effective strategy historically has been to maintain one’s long-term outlook when it is perhaps most difficult to do so. Over many down cycles in equity prices I have observed many long-term investors that have simply “thrown in the towel” and sold all their holdings. Some even think that they will then reinvest at a more “opportune” time. My observations have shown that virtually no long-term investors get “back in” at an opportune time and some never reinvest. If one has abandoned equities, whenever stocks finally rebound convincingly, it is a virtual certainty that many substantial gains might not then be realized. It is our opinion that the most effective long-term investment strategy must incorporate a patient approach. This does not mean that one sits by “idly” and does nothing. We have been advocating for quite some time that on days such as Wednesday of this week when there is “indiscriminate” selling of equites – only eight out of 500 stocks in the S&P 500 were positive – that long-term investors should take advantage of such days to “upgrade” their portfolios to better high-quality stocks with better risk/reward attributes. We have advocated also for most of this entire year that investors should buy only on days of market downturns or alternatively, to buy selected stocks on days when a desired particular security traded lower and presented a better risk/reward point of entry.


Forecasting Made More Difficult

On the day of Russia’s invasion – February 24 – we decided that the number of variables and uncertainties exponentially increased to such an extent that we did not feel as comfortable favoring certain sectors to the exclusion of others. From that day, our goal has been to find the best quality stocks with solid balance sheets, good cash flows and relatively stable margins in whatever sector such stocks resided. Since that day, the number of variables and uncertainties have continued to multiply. Forecasting has become more difficult and has become more data dependent for us. We will not hesitate to change our opinion to the extent that – in our view – data would support a different conclusion or outcome than what we were anticipating. We have observed that many analysts and investors have shown a very deep reluctance to revise their earnings estimates on most U.S. companies. We are convinced that these analysts and investors are “behind the curve” in revising their estimates, much like we were convinced for quite some time that the Fed was behind the curve in failing to adopt a tighter monetary policy in response to inflation by overstaying their interpretation of inflation as “transitory.”


Faulty Forecasting at Walmart and Target Along with Abandoned “Just-in-Time” Inventory Policies

Most analysts appear to be resolute in their earnings estimates even after the dramatic announcements of Walmart and Target on consecutive days. These two companies are noted for their superiority in logistics management. Their ability to forecast was shown to be severely lacking. The quick and dramatic changes in consumer spending patterns happened much more quickly than anticipated. Walmart noted a trend for consumers to “trade down” in their purchases as well as inflationary cost pressures, including increased fuel costs in the supply chain. The wage component of their costs were also higher than anticipated as workers returned to work from COVID-19 related leaves more quickly than anticipated. In other words, Walmart “over-hired.” The Target experience also showed an inability to accurately forecast their needs. Target admitted that they did not anticipate a dramatic shift in consumer spending away from “bulky” items, such as TVs, and more toward items such as luggage that were more directed at the reopening of the economy. Profit margins, like those of Walmart were impacted severely. These two disappointing “margin” stories are dramatic examples of inaccurate forecasting. Unfortunately, given that supply chain disruptions and constraints have in our opinion permanently changed many companies’ reliance on “just-in-time” inventory strategies because of supply chain unreliability, the need to forecast has risen at a time when forecasting has become merely “guesswork.” In our opinion, these changes in circumstances, particularly in regard to the change in consumer patterns, should have been rather obvious. The only question was the timing of these changes.


Still Waiting For Downward Earnings and Margins Revisions by Analysts

Many of our commentaries anticipate revisions lower in margins and earnings of many companies. We still have not detected any general willingness of analysts to revise their estimates lower. We have observed over many years that analysts’ estimates tend to congregate very closely with one another. If an analyst chooses to be the “outlier” in their estimates they better be right. An outlier who is wrong can be expected to have a shortened career. Nevertheless, we are still baffled by the stubbornness of analysts to maintain their estimates in light of the constantly changing landscape even after two of the giants in logistics management could not forecast accurately in the short term.


Economists Downgrade U.S. Growth for 2022 and 2023

The economists at major banks appear less reticent to change their forecasts to account for incoming data which show a slowdown in consumers’ willingness to spend, an increase in their borrowing – which we indicated in last week’s commentary –, a slowing housing market, increased borrowing for consumer loans including auto loans and credit card loans, and weakening manufacturing surveys. On May 14, Goldman Sachs remarked that there was a slowdown in U.S. consumer spending in late April and early May, and that this was “perhaps in response to tighter financial conditions and higher consumer prices.” Goldman sees a high likelihood of consumer spending weakness to continue into June. Affirming this view, was the University of Michigan’s consumer sentiment reading for early May released last Friday and which registered an 11-year low reading. We consider the economic data released this week as “mixed.” And yet, analysts apparently see no reason to change their earnings estimates. But at least the economists at J.P. Morgan (JPM) and Goldman Sachs did lower their GDP estimates for the U.S. for the second half of 2022 and full-year 2023. While China’s government maintains their 5.5% growth target for 2022, Goldman also lowered its 2022 GDP forecast for China to 4.0% from its last estimate of 4.5%.


Selected Economic Data

Let’s take a closer look at selected economic data released this week:

Perhaps the most negative survey release this week was the NY Fed’s Empire Manufacturing survey for business activity in the NY area, for which the responses were collected between May 2 and May 9. The headline business conditions index declined 36 points to 11.6, new orders registered their second negative reading in the past three months, shipments fell at the fastest pace since early in the pandemic, and prices remained elevated.



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Source: J.P. Morgan, US: Empire State survey drops into negative territory again (5/16/2022)


The Philadelphia Fed’s survey of manufacturing activity – responses collected May 9 to May 16 – was released later in the week and was also somewhat disappointing, but not nearly as bad as the Empire State survey. The headline index for current business activity declined 15 points to a two-year low of 2.6. However, new orders rose and the shipments index rose to its highest level since October 2020. The index for future business activity declined to its lowest level in 13 years. Although manufacturers increased their expectations of inflation rates for consumers to 6.5% over the next year compared to a 5% expectation in February, this survey also showed that they maintained their expectation that they would only be able to raise the prices they charge at the same 5% level as expected in February. This data indicates clearly an expected loss of pricing power and lowered margin expectations.

U.S. retail sales were considered generally to be positive, even though the headline number was +0.9% month-over-month (m/m) versus expectations of +1.0%. This was due to the sharp upward March revision from +0.7% to +1.4%. The April reading was the smallest gain in four months, but spending gains were generally broad based. The sales decline of 2.7% m/m at gasoline stations was notable. This decline reflected mainly the decline in gasoline prices. We expect this to be reversed in May as gasoline prices have resumed their ascent this month. Auto sales were positive by 2.2% m/m, reversing a sharp drop in March. Auto sales have been very volatile over the past year, mostly due to semiconductor chip shortages. Restaurant sales were positive by 2.0% m/m. This is the only service sub-sector included in retail sales. Excluding auto sales and gas station sales, retail sales in April gained 1.0% m/m.


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Source (left): J.P. Morgan, US: Retail sales are solid in April despite headwinds (5/17/2022)
Source (right): U.S. Census Bureau, ADVANCE MONTHLY SALES FOR RETAIL AND FOOD SERVICES, APRIL 2022 (5/17/2022)


The business leaders survey of service firms – responses collected between May 2 and May 9 – conducted by the NY Fed showed a decline in its headline business activity index falling 13 points to 11.5. The business climate index also fell, “indicating that firms generally viewed the business climate as worse than normal for this time of year.” Optimism continued to “wane” as less than 50% of respondents expected business activity to increase over the next six months.

Total U.S. industrial production increased 1.1% m/m in April. This was the fourth consecutive month which showed an increase of at least 0.8%. Manufacturing capacity utilization increased by 0.6% m/m to 79.2% in April, its highest level since April 2007.

U.S. business inventories rose at a slightly-better-than-expected rate of 2.0% m/m, signaling that companies continued to replenish their stockpiles amid supply chain disruptions.


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The National Association of Home Builders (NAHB) housing index fell for the fifth straight month. In May the index fell to 69 from 77 in April and versus an expected level of 75. This was the lowest reading since June 2020. Sales expectations over the next six months dropped by 10 points to 63. This survey was best summarized by the chief economist of NAHB Robert Dietz: “The housing market is facing growing challenges. Building material costs are up 19% from a year ago; in less than three months mortgage rates have surged to a twelve-year high, and based on current affordability conditions, less than 50% of new and existing home sales are affordable or a typical family.”



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Source: J.P. Morgan, US: Existing home sales continue to slide (5/16/2022)


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Source: U.S. Census Bureau, MONTHLY NEW RESIDENTIAL CONSTRUCTION, APRIL 2022 (5/18/2022)


Between April 25 and May 9, the Conference Board conducted a survey of 133 mostly public companies’ CEOs and has released the findings of the survey mid-week. The key findings included the following:

1) 61% of surveyed CEOs thought that economic conditions have worsened over the past six months versus 35% who said this in Q1.

2) 60% of CEOs expect business conditions to worsen versus 23% in Q1.

3) 68% of CEOs expected a recession “over the next few years”, but only 11% expected a “hard landing.”

Difficulty in attracting qualified workers was reported. Only 54% of CEOs planned to pass along rising input costs to consumers. This is yet another example of possible profit margin compressions looming in the future.

We believe that our summary of the most recent economic data indicates a slowing U.S. economy with high wages and elevated inflation.


Comparing a Potential Bottom in U.S. Equities to Prior Bottoms

We chose to compare a potential sustainable bottom for U.S. equities in the present environment to the bottoms of March 2020 and March 2009. In our estimation, it will be much more difficult to predict accurately a bottom in the current environment. But this will not stop us from attempting to do so. We thought that the two bottoms referenced above were relatively easy to spot. It is our understanding that the explanation lies in the actual fear of investors and that in both instances the problem was clear and discernable. The more extreme of these two examples in our opinion was March of 2009, when there was a real fear of our financial system collapsing. Very few people were asking for any “buy” ideas. It was a fear of the unknown. It was also “so bad” that one had to assume that the Fed and other branches of government would have little choice but to come to the rescue. The COVID-19 fears and world-wide lockdowns in Q1 2020 were clearly focused as well. Again, one could reasonably expect that the government would do “whatever it took” to stabilize our economies and financial markets. The current environment is entirely different. Although it might seem that there is only one issue, namely inflation, it has become much more complicated. Recession and/or stagflation fears are now mentioned prominently as well. Variables are constantly multiplying and uncertainties continue to increase. We cannot expect reasonably any government entity to come to our rescue. In fact, it is just the opposite. Many analysts and investors think that the Fed might very likely even exacerbate our many issues. We suppose that the difficulty in forecasting how and when our many issues will be resolved will also make it more difficult to call accurately a sustainable bottom in equity markets.


Bottom Line

We assume continued volatility across virtually all financial markets for at least as long as the war persists. We assume that the 10-year Treasury yield’s drop of 10 basis points on Wednesday was due mostly to “flight to safety.” We continue to forecast higher 10-year Treasury yields in a volatile pattern. We assume that a downward trajectory in Treasury yields would be a negative sign for U.S. equities at the present time.

There are increasing indications that consumer spending and U.S. economic growth might be slowing. We continue to recognize that decreased liquidity in financial markets will tend to increase volatility. The U.S. dollar looks increasingly that it might be putting in a “top.” We suppose that a lower USD will enhance global economic growth in the current environment.

We think that Thursday’s trading might indicate at least a short-term bottom in U.S. equities. We will be very quick to change our view on this. Unfortunately, we do not believe that we have yet to reach a sustainable bottom in U.S. equities. We view that analysts’ revisions of their margins and earnings estimates might need to be revised lower as a prerequisite. We maintain our conviction that predictable margins should become increasingly important in evaluating appropriate investments.

Our basic investment approach remains the same as expressed in our most recent commentaries. We maintain our preference for high quality stocks in a diversified portfolio with at least some commodity exposure.


U.S. Dollar Index (DXY) – The U.S. dollar index (DXY) is a measurement of the dollar’s value relative to six foreign currencies as measured by their exchange rates. Over half the index’s value is represented by the dollar’s value measured against the euro. The other five currencies include the Japanese yen, the British pound, the Canadian dollar, the Swedish krona, and the Swiss franc.

NAHB/Wells Fargo Housing Market Index (HMI) – The NAHB/Wells Fargo Housing Market Index (HMI) is a monthly sentiment survey of members of the National Association of Home Builders (NAHB). The index measures sentiment among builders of U.S. single-family homes, and is a widely watched gauge of the U.S. housing sector. Since housing represents is a large capital investment and spurs additional consumer spending on appliances and furnishings, housing market indices help to monitor the overall health of the economy.


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